Monday, 24 June 2013

Executive Pay and Social Stability

By Tom Lloyd
Visiting Fellow to Northampton Business School

Apologists and beneficiaries of huge executive pay packets talk of the ‘rate for the job’, and the ‘commercial realities’. Opponents and critics talk of greed, unfairness, and the exploitation of the weak by the strong. The former say the latter don’t understand how markets work. The latter say the former refuse even to acknowledge the possibility that their sense of entitlement is exaggerated.

It is a dialogue of the deaf. The protagonists transmit, but don’t receive. There seems to be no common ground on which to debate and thereby reach some kind of resolution to one of the most important  socio-economic issues of our age.

Two articles in the Financial Times of June 10, 2013 exemplify the great divide, and inadvertently suggest how it might be bridged.

The first on page three in the main paper reports that ‘The median total remuneration of FTSE 100 chief executives rose 8% [about six times the growth in average earnings in the UK economy as a whole] to £3.7m last year’, as higher share prices ‘drove a windfall from long-term incentive plans.’ The figures, from proxy voting agency, Manifest, and remuneration consultants, MM&K, show that the growth of CEO earnings has continued unabated, throughout the traumas and recessions of recent years that some, myself included, hoped would put a brake on the executive pay explosion. Between 1998 and 2012 the average pay of FTSE 100 bosses grew from 47 times to 133 times their employees’ average earnings.

There is no reference in the page three report to the John Authers column on page 20 in the Companies section of the FT, head-lined: ‘Elitist systems carry seeds of their own destruction’ and Authers makes no reference to the page three piece. Once spotted, however, the connection is obvious. The three books Authers refers to - Why Nations Fail, by Daron Acemoglu and James Robinson, When the Money Runs Out, by Stephen King, Balance – The Economics of Great Powers from Ancient Rome to Modern America, by Glenn Hubbard - all argue, says Authers, that ‘political systems that intensify inequality or that work exclusively for the benefit of particular groups, carry with them the seeds of their own destruction.’ History is littered with examples: the Bourbons, in France; the Romanovs, in Russia; the Stewarts, in Britain; the Pahlavis, in Iran; and more recently dictators in North Africa.

The three recently published books Authers mentions echo a warning in my own book, Business at a Crossroads. The crisis of corporate leadership (Palgrave Macmillan, 2009), in which I argued that very high levels of top executive pay are undermining what I called the ‘liberal-capitalist consensus’.

A shared wish for political stability is the common ground for the apologists for, and critics of, very high levels of executive pay. Both sides in the debate have an interest in ensuring the seeds of self-destruction in the high, still growing levels of inequality generated by the executive pay explosion do not germinate and lead to social instability. Social instability impoverishes people and disrupts the efficient working of the wealth creation process from which senior executives skim such a disproportionate share.

It’s on this common ground, the common desire for stability, where the essential question must be settled. 

Is the great wealth of company executives a creature of capitalism itself; or is it rather a creature of inefficiencies in the market for senior executives?

If the indulgence of natural human impulses in a capitalist system leads inevitably to enormous disparities in income and wealth then such disparities, and the sense of unfairness they foster, are the price we have to pay for the superior allocative efficiency of the free market system. Until, that is, the seeds of self-destruction germinate, and ordinary people demand another, less efficient, but more equitable system.

If, as we should all hope and as actually seems more likely, given the adaptability that capitalism has demonstrated in the past, the fault lies not in the system itself, but in market inefficiencies, then the executive pay problem is corrigible and the market for  executive talent could, in time, become as efficient as the market for Premiership footballers.
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[The views and opinions expressed in this blogs by guests or members of the CCEG are those of the author, and not of the CCEG or the University of Northampton Business School]

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Wednesday, 5 June 2013

Tax Ethics

By Tom Lloyd
Visiting Fellow to Northampton Business School

Tax avoidance is legal. Tax evasion is illegal. That much is clear and undisputed. But, as the row over the tax policies of companies such as Starbucks, Google and Apple has shown, this distinction no longer provides a sharp dividing line between fiscal propriety and impropriety. That line has become more than blurred; it has become a vast grey area awash with ethical controversies and accusations, public indignation, political point-scoring, mutual recriminations and fundamental conflicts of interests and duties.

The current, official line seems to be that there is a category of ‘tax planning’ behaviour lying between legal avoidance and illegal evasion that complies with the letter of tax law, but violates the spirit, which is to say the intent of the tax authority concerned.

Some tax planning is not only acceptable – it is desirable. When a corporate taxpayer brings forward investment, for example, to take advantage of a temporary accelerated depreciation provision, it is behaving as the government intends. But so-called ‘aggressive’ tax planning, as some tax authorities call it, such as routing profits on sales in one jurisdiction (such as the UK) through a lower-tax jurisdiction (such as Ireland) is morally, if not legally wrong. The argument here is that it is unfair to deprive customers in the country where sales are made of tax revenues associated with those sales, by artificially re-routing taxable earnings elsewhere.

There are two problems with this argument. 

The first is that it ignores the duty of company managers to their shareholders to maximise shareholder value. The managers of a firm operating in several tax jurisdictions who failed to make the most of differences between those jurisdictions in rates and allowances would be failing in their fiduciary duty to shareholders, many of whom will be pensioners and savers, to maximise ‘total shareholder returns’ (dividends + capital gains).

This is not, or not only, vested interests masquerading as a moral principle. The duty managers have to shareholders is real and part of the contract between directors and investors. A CEO who takes a high moral line and forswears use of anything other than the most pacific and proper tax planning would be in breach of contract and at risk of summary dismissal.

The second problem with the assertion that it is immoral to engage in ‘aggressive’ tax planning, particularly when it is asserted by ministers and civil servants, is that governments are themselves deeply implicated in the growth of aggressive tax avoidance. Their feverish efforts to develop tax systems that are ‘competitive’ in the global market for foreign investment has led to intense ‘tax competition’, as governments around the world vie with one another to attract, or retain foreign capital with low head-line tax rates and extended ‘tax holidays’ for foreign investors.

It borders on the disingenuous for governments and tax authorities that have, by engaging in tax competition, created the opportunity for aggressive tax planning, then to take a high moral tone with firms that exploit that opportunity. If governments don’t like the way that companies are legally avoiding taxes, they should either tighten tax law, abandon direct taxation of profits altogether, or change the basis of corporate income tax.

An interesting suggestion by Michael Devereux of the Saïd Business School (Financial Times, May 23, 2013) is to switch the basis of corporation tax from where profits are earned, to where sales are made. He proposes the adoption of VAT’s ‘destination principle’. The profits of multinational companies would be taxed on the basis of sales to UK residents. Imports would be taxed; exports would be exempt.

In the absence of such a switch to a more rational, less avoidable basis of company taxation, governments will continue to paper over the cracks in their tax systems by insisting that multinational companies have a moral duty to subordinate the interests of their shareholders to those of tax payers in the countries in which they operate.
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